Thinning Patience for Low Profits Could Equal Higher Amazon Prices

Photo: Jim Merithew / Wired

Among Amazon skeptics, patience for the online retailer’s lack of profits has become a source of bemused agony. No other marquee tech company could get away with, at best, earnings in the low millions (to say nothing of ending last year in the red). Despite such low numbers, Amazon’s shares have enjoyed unprecedented success over the last few months.

But the past few days have seen the onset of what could turn into what the short sellers would see as a major correction. If so, it’s not only shareholders who could suffer. A major stock downturn led by investors no longer willing to wait for Jeff Bezos to work miracles could eventually mean higher prices for Amazon customers.

To understand why, first consider the fortunes of one of Amazon’s main rivals.

Last October, about a month into what would become Apple’s epic six-month stock slide, CEO Tim Cook told investors he was “proud to end a fantastic fiscal year with record September quarter results.” Profits topped $8 billion, a nearly 25 percent increase. Sales of iPhones and iPads were spiraling upward. And sales for the Christmas quarter were expected to be even higher—$52 billion in all.

Wall Street looked at those numbers and rendered a decisive verdict: “You suck.”

Within two months, Apple shares had fallen another $100. Since then, Apple has reported two more quarters of massive profits—including an eleven-figure holiday season. And it’s still not clear, after closing this month below $400 for the first time since 2011, whether Apple’s stock price has bottomed out yet.

While Apple can apparently do no right in investors’ eyes, owing to the astronomical expectations its successes have set, Amazon until recently could seem to do no wrong.

Keep in mind those Apple numbers, then consider Amazon’s results. The same day in October that Apple reported its not-good-enough $8 billion in profits, Amazon announced a loss of $274 million for its most recent quarter. Amazon’s stock price fell briefly, but then resumed an upward journey the company’s shares have enjoyed since the 2008 crash. In late January, Amazon shares hit an all-time high. A few days later, the company declared it had ended its fiscal year in the red.

Nevertheless, Amazon stock still was trading at near peak prices until this past Thursday, when the company revealed another quarter of unsurprisingly mediocre profits. Since then, shares have fallen nearly 10 percent.

For Paulo Santos, the shift could not come sooner. Since late 2011, the self-described independent trader and analyst based in Portugal has made a prolific, impassioned case against Wall Street’s rosy view of Amazon. On Seeking Alpha, the popular investment blog, Santos is the leading Amazon bear, a relentless voice of doubt that Amazon will ever be the wildly profitable company all the buyers pushing up its stock price seem to suggest it one day will be.

The crux of Santos’ argument is that as Amazon sells more merchandise—which it does every year—the costs of that selling rise faster than the revenues Amazon brings in. In other words, he believes that selling more won’t make Amazon any more profitable. If Amazon can’t shore up its profits by lowering its costs, Santos says the company’s famously low prices—a key competitive advantage—will start to creep up:

As long as Amazon.com isn’t a cost leader, you can’t expect it to compete on price for long. Other large general merchandise mail order houses from the distant past, such as Montgomery Ward or the Sears Catalog, also went through a similar process, where they lost pricing advantage against traditional retail and then slowly withered away.

Santos’ belief that e-commerce is little more than the mail order catalog business with an online face puts him far outside the Wall Street mainstream, where bullish analysts counsel patience until Amazon’s heavy spending on infrastructure pays off. The company’s recent spending spree on warehouses, for example, have taken a big chunk out of its bottom line in recent quarters. But some analysts are extremely optimistic that such investments will make Amazon a peerless logistical machine for selling and delivering consumer goods to the world. In this scenario, the resulting efficiencies will finally push Amazon’s margins up while prices stay down.

One possible sign of trouble—the kind of sign Santos sees as a wailing siren—is rising quarter-over-quarter shipping costs. One optimistic explanation for the increase is that those rising costs are due to the popularity of Amazon Prime, which promises unlimited two-day shipping for an annual fee. While such a promise costs Amazon more, at least one deep dive into Amazon’s numbers has shown convincingly that Prime customers more than offset the cost by buying so much more from Amazon than their non-Prime counterparts.

The next year or so should start to offer some clarity on which vision of Amazon’s future will shake out. If Amazon’s warehouses start humming, Prime customers keep coming and Kindles keep selling, Amazon’s margins should rise, and shareholder patience will be rewarded. But if Santos is right and costs don’t come down, Amazon’s 200 million customers could see higher prices sneaking into their online shopping carts. After all, it’s not the 1990s anymore: Amazon doesn’t just sell books, and internet companies at some point actually have to start making money.